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In my paper, 鈥淢onopsony Power and Upstream Innovation鈥� (joint with Guillermo Marshall), I explore how a monopsonist鈥攁 firm that is the sole buyer of inputs from suppliers鈥攃an influence its suppliers鈥� incentives to innovate. The motivation for this study comes from real-world examples where companies like Apple and Boeing are known to 鈥渟queeze鈥� their suppliers by cutting input prices and reducing order volumes, all in an effort to drive innovation within their supply chains.

The key insight from my research is that a monopsonist can actually enhance a supplier鈥檚 motivation to innovate by strategically lowering the supplier鈥檚 short-run profits. This approach might seem counterintuitive, but it works by reducing the supplier鈥檚 鈥淎rrow鈥檚 replacement effect.鈥� This effect occurs when a supplier鈥檚 incentive to innovate diminishes because the profits from the new product are only marginally better than the existing one. By squeezing the supplier and lowering its current profits, the monopsonist widens the gap between the profits of the current and potential new products, thereby increasing the supplier鈥檚 incentive to invest in research and development (R&D).

However, this strategy comes with trade-offs. While it can drive innovation, squeezing the supplier leads to inefficiencies in the supply chain by distorting the trade volume between the monopsonist and the supplier, ultimately reducing overall economic efficiency. Despite these inefficiencies, my findings suggest that firms in innovative industries might still prefer to maintain separate operations rather than vertically integrating鈥攗nless the potential innovation is substantial enough to justify the inefficiency costs.

In conclusion, my research highlights a nuanced strategy where monopsonists can drive supplier innovation at the expense of supply chain efficiency.